The Spitfire's Grill
Regular Rants from a Pragmatic Liberal
Friday, May 20, 2005
 
Topic of the Day: The Euro
Today's Topic of the Day was inspired by this NYTimes article which highlights a rather fascinating conundrum.

THE EURO

Almost exactly a year ago I went off to Europe for about 10 weeks for a study abroad program. Those 10 weeks were packed with a myriad of learning (and fun) activities. The Euro, despite my distaste for its value over the dollar, was quite a convenient monetary system for a place where the equivalent of 30 American Dollars could get you into another country with a completely different economic system yet the same currency. One of the things I had pondered, however, was how those different economic systems affected the Euro, and this NYTimes article seems to address that.
Far from converging into a more homogeneous bloc, the 12 countries that use the euro currency are dispersing into sprinters and laggards, with different levels of consumer confidence, industrial activity, and economic vigor. Bustling Ireland, with a growth rate of 5 percent, has little in common with becalmed Italy, where output may actually shrink this year.
This isn't entirely unexpected, of course. Each country has different policies that encourage industry or protect labor and the environment. Remember that this is partially true inside the United States, as individual states have a small amount of leeway over encouraging business. But since most of this is done at the federal level, the state's individual economies stay relatively close together in terms of growth and recession.

So why is this a problem? Well open a high school economics text book and you'll learn there are two main things a government can do to fix an economy: fiscal and monetary policy. Fiscal policy involves budget deficits and surpluses (will someone remind Bush what a surplus is, please?). Monetary policy involves manipulating interest rates on loans. If a country is in an inflation period, raise rates, if its in a recession period, lower them. Monetary policy is seen as the most politically isolated here in the United States--and indeed in Europe as well--because it can largely be controlled by a central bank. But the central bank for the Euro is the central bank for all of those countries, whether their economy is good or bad (imagine if one country had record inflation and the other had a record recession, ouch!). Ouch indeed:

This has created a conundrum for the European Central Bank in Frankfurt, which sets interest rates for much of the Continent. Just as the Federal Reserve, to some extent, must take into account divergent conditions in Ohio and Arizona, the European bank is learning that it is even trickier to devise a monetary policy that works equally well from Finland to Greece.

For months, the bank has signaled it wants to lift rates. But it is afraid of hobbling weak countries like Germany and the Netherlands. While the Germans linger on the edge of a recession, Spaniards are surfing on a sea of easy money, taking out cut-rate mortgages to buy and build houses at a furious pace.

[...]

The euro has proved remarkably resilient since its debut in 1999, confounding those who warned that a pan-European currency would be inherently unstable or vulnerable to outside shocks. It has withstood the recent surge in oil prices, and has grown in credibility, particularly as the dollar has lost some of its luster.

But the widening divide between euro countries has revived some of the warnings about the pitfalls of a monetary union.

And remember that example if one country had high inflation and the other a recession? That's practically a reality. Countries like Ireland and Spain have an explosive growth--5% and 3%, respectively. Spain's inflation is at 3% right now. But countries like the Netherlands and Germany are in quite a hole, the article quotes Germany's unemployment rate at around 11.8%. While Germany isn't quite in a recession yet--its growth numbers are teetering somewhere in between 0 and 1%--they definitely could use an interest rate cut.

Who knows, this might work out eventually for Europe if their economic systems start to converge, and especially if they approve the EU Constitution (doesn't look like they will, however). But this will definitely continue to be a problem and both recessions and inflationary periods will end up running for quite a long time.

One final thought. In the US, there's a population shift to the south that naturally hurts northern economies and aides southern ones. This certainly accounts for much of the disparity between state's economies. But people, other than state governors and legislators, don't worry about this in terms of monetary policy because the jobs are simply being transported within the US. This isn't possible in Europe. Why? ¿No hablan alemán? The language barrier. You can't simply move a German company to Spain because you can't expect your current employees to speak Spanish and hiring all new employees will come at a huge cost in productivity.


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